What is 'Implied Volatility  IV'
Implied volatility is the estimated volatility, or gyrations, of a security's price and is most commonly used when pricing options. In general, implied volatility increases when the market is bearish, when investors believe that the asset's price will decline over time, and decreases when the market is bullish, when investors believe that the price will rise over time. This is due to the common belief that bearish markets are riskierÂ than bullish markets.Â Implied volatility is a way of estimating the future fluctuations of a security's worth based on certain predictive factors.
BREAKING DOWN 'Implied Volatility  IV'
Implied volatility is sometimes referred to as "vol" or "IV." Volatility is commonly denoted by the symbolÂ ÏƒÂ (sigma).
Implied Volatility and Options
Implied volatility is one of the deciding factorsÂ in the pricing of options. Options, which give the buyer the opportunity to buy or sell an asset at a specific price during a predetermined period of time,Â have higher premiums withÂ high levels of implied volatility,Â and vice versa. Implied volatility approximates the future value of an option, andÂ the option's current value takes this into consideration.
It is important to remember that implied volatility is all probability. It is only an estimate of future prices, rather than an indication of them. Even though investors take implied volatility into account when making investment decisions, and this dependence inevitably has some impact on the prices themselves, there is no guarantee that an option's price will follow the predicted pattern. However, when considering an investment,Â it does help to consider the actions other investors are taking in relation to the option, and implied volatility is directly correlated with market opinion, which does in turn affect option pricing.
Another important point to note is that implied volatility does not predict the direction in which the price change will go. For example, high volatility means a large price swing, but the price could swing very high or very low or both. Low volatility means that the price likely won't make broad, unpredictable changes.
Implied volatility is not the same as historical volatility, also known as realized volatility or statistical volatility. Historical volatility measures past market changes and their actual results. Still, it isÂ helpful to consider historical volatility when dealing with an option, as this can sometimes be a predictive factor in the option's future price changes.
Implied volatility also affects pricing of nonoption financial instruments, such as an interest rate cap, which limits the amount by which an interest rate can be raised.
Option Pricing Models Based on Implied Volatility
Implied volatility can be determined by using an option pricing model. It is the only factor in the modelÂ that isn't directly observable in the market; rather, the option pricing model uses the other factors to determine implied volatility and options premium. The BlackScholesÂ Model, the most widely used and wellknown options pricing model, factors inÂ current stock price, options strike price, time until expiration (denoted as a percent of a year), and riskfree interest rates. The BlackScholesÂ Model is quick in calculating any number of option prices. However, it cannot accurately calculate American options, since it only considers the price at an option's expiration date.
The Binomial Model, on the other hand, uses a tree diagram, with volatility factored in at each level, to show all possible paths an option's price can take, then works backwards to determine one price. The benefit of this model is that you can revisit it at any point for the possibility of early exercise, which means that an option can be bought or sold at its strike price before its expiration. Early exerciseÂ occurs only in American options. However, the calculations involved in this model take a long time to determine, so this model isn't best in rush situations.
What Factors AffectÂ Implied Volatility?
Just as with the market as a whole, implied volatility is subject to unpredictable changes. Supply and demand is a major determining factor for implied volatility. When a security is in high demand, the price tends to rise, and so does implied volatility, which leads to a higher option premium, due to the risky nature of the option. The opposite is also true; when there is plenty of supply but not enough market demand, the implied volatility falls, and the option price becomes cheaper.
Another influencing factor is time value of the option, or the amount of time until the option expires. A shortdated option often results in a low implied volatility, whereas a longdated option tends to result in a high implied volatility, since there is more time priced into the option and time is more of a variable.
Â
Â

Volatility Arbitrage
Volatility arbitrage is a trading strategy that attempts to profit ... 
Volatility Smile
A ushaped pattern that develops when an optionâ€™s implied volatility ... 
Option Premium
1. The income received by an investor who sells or "writes" an ... 
Calendar Spread
A calendar spread is a lowrisk, directionally neutral options ... 
TimeVarying Volatility
Fluctuations in volatility over time. Volatility is the standard ... 
Volatility Swap
A forward contract whose underlying is the volatility of a given ...

Trading
Implied Volatility: Buy Low and Sell High
This value is an essential ingredient in the option pricing recipe. 
Trading
Ratio Writing: A HighVolatility Options Strategy
Selling a greater number of options than you buy profits from a decline back to average levels of implied volatility. 
Trading
The Anatomy of Options
Find out how you can use the "Greeks" to guide your options trading strategy and help balance your portfolio. 
Trading
An Option Strategy for Trading Market Bottoms
A reverse calendar spread offers a lowrisk trading setup with profit potential in both directions. 
Trading
Strategies for Trading Volatility With Options (NFLX)
These five strategies are used by traders to capitalize on stocks or securities that exhibit high volatility. 
Trading
Stock Options: What's Price Got To Do With It?
A thorough understanding of risk is essential in options trading. So is knowing the factors that affect option price. 
Trading
The Ins and Outs of Selling Options
Selling options can seem intimidating, but with these tips you can enter the market with confidence. 
Trading
The Potential Of LowPriced Options
The benefits of trading lowpriced options, and learning how to pinpoint them, can be a very profitable strategy for an options trader.

How does implied volatility impact the pricing of options?
Learn about two specific volatility types associated with options and how implied volatility can impact the pricing of options. Read Answer >> 
Can delta be used to calculate price volatility of an option?
Learn how implied volatility is an output of the BlackScholes option pricing formula, and learn about that option formula's ... Read Answer >> 
What is the relationship between implied volatility and the volatility skew?
Learn what the relationship is between implied volatility and the volatility skew, and see how implied volatility impacts ... Read Answer >> 
How is implied volatility used in the BlackScholes formula?
Learn how implied volatility is used in the BlackScholes option pricing model, and understand the meaning of the volatility ... Read Answer >>